In the United States around 1945, some institutions outside universities provided intellectual support and culture for left-wing intellectuals, including economists. I refer to schools for workers supported to some extent by the Communist Party:

School for Jewish Studies (New York)

Jefferson School for Social Science (New York)

Abraham Lincoln School (Chicago)

Samuel Adams School (Boston)

Boston School for Marxist Studies

Tom Paine School of Social Sciences (Philadelphia)

Walt Whitman School of Social Sciences (Newark)

Joseph Weydemeyer School of Social Sciences (St. Louis)

Ohio School of Social Sciences (Cleveland)

Michigan School of Social Sciences (Detroit)

Seattle/Pacific Northwest Labor School

Tom Mooney/California Labor School (San Francisco)

Under Truman, these schools were listed by the Attorney General as subversive. With continued McCarthyist oppression, none existed by 1957.

On the other hand, extremely rich reactionaries paid economists to argue for right wing views. This funding went to both universities and to think tanks set up since the workers' schools were shut down. Some examples:

Harold Luhnow, who made his fortune selling furniture, is important for the history at, among other places, the University of Chicago (Van Horn and Mirowski 2009)

Jasper Crane, a former executive of the DuPont Chemical Company was a major funder at one point of the Mont Pélerin Society (Phillips-Fein 2009)

Sir Antony Fisher, who introduced factory farming into Great Britain, set up the Institute of Economic Affairs in Great Britain (Blundell 2007, Mitchell 2009)

Leonard Read led the Foundation for Economic Education

Edward H. Crane founded the Cato Institute in 1977

Perhaps the long history of oppression of economists with certain views and funding of economists with others has had some influence on what ideas are developed. The above only provides a very limited glimpse of political interventions into academic economics. Much more can be found for those willing to look.

Frederic Lee (2009) A History of Heterodox Economics: Challenging the Mainstream in the Twentieth Century, Routledge

Timothy Mitchell (2009) "How Neoliberalism Makes Its World: The Urban Property Rights Project in Peru", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.

Kim Phillips-Fein (2009) "Business Conservatives and the Mont Pélerin Society", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.

Rob Van Horn and Philip Mirowski (2009) "The Rise of the Chicago School of Economics and the Birth of Neoliberalism", in The Road from Mont Pélerin: The Making of the Neoliberal Thought Collective (ed. by Philip Mirowski and Dieter Plehwe), Harvard University Press.

Saturday, May 22, 2010

"Yet when, having produced a destructive critique of the neoclassical production function, [Sylos Labini] asks, 'When will economists finally accept their own logic?' I do believe he is not just sniping from the sidelines at the Neoclassical Paradigm (NCP), he is shaking at one of its foundation stones. For this reason my short answer to his question is 'Never' or at least 'Not until we have a new paradigm...'

...I am convinced that this concept of general equilibrium in a monetary economy [with markets for real product, the stock of money, labour, and the stock of bonds] constitutes the primal scene - the primitive imaginary vision of the world - out of which the whole of mainstream macroeconomics now flows. At one extreme are 'monetarists' of various hue who believe that the classical version of this simple model does, or should, or can somehow be made to describe the real world. Almost all other modern macroeconomists, while forming a huge spectrum, have as their essential activity the study what happens if parts of the machine do not function properly, e.g. are subject to rigidities or time lags. For instance, much work has been concerned with effects on the solution of this model if the various prices do not clear markets or clear them imperfectly. If wages are not flexible the labour market may not clear; this is what most students now understand as Keynesian economics. If the price of goods is not flexible, the market for goods may not clear, perhaps generating 'classical' unemployment.

Now Sylos Labini (like Kaldor and Pasinetti in different ways) makes a devastasting case against the empirical relevance or even meaningfulness of the aggregate neoclassical production function. What I want to emphasize here is the system role which the production function fulfils and therefore just why the Sylos Labini critique is so important. What the production function does for all equilibrium systems - whether markets clear or not - is to bring labour into instantaneous equivalence with real product in such a way that alternative quantities of each can potentially be traded against one another. The production function is necessary for this equivalence so that labour can instantaneously be translated into the profit-maximising quantity of product which firms are therefore motivated to supply. Without the production function no neoclassical model will start up; the blood supply to its head is cut off...

...I have reached a point when I am prepared to make a declaration. I want to say of neoclassical macroeconomics what I have sometimes said of certain kinds of fiction; I know that the world is not like that and I have no need to imagine that it is. In particular, I do not believe that there exists a market in which goods in aggregate and labour in aggregate can be exchanged for one another provided only that the price of each is right in relation to some given stock of 'money.'" -- Wynne Godley (1993) "Time, Increasing Returns and Institutions in Macroeconomics: Essays in Honour of Paolo Sylos Labini", in Market and Institutions in Economic Development (ed. by S. Biasco, A. Roncaglia and M. Salvati), St. Martin's Press.

Godley goes on in this paper to outline a stock-flow consistent macroeconomic model with both real and monetary sectors.

Wednesday, May 19, 2010

Milton Friedman defined the natural rate of unemployment, also known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU), at least at the level of abstraction of this post:

"The 'natural rate of unemployment' in other words, is the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is embedded in them the actual structural characteristics of the labor and commodity markets." -- Milton Friedman (1968), as quoted in James K. Galbraith (1998)

Two mathematical mistakes are embedded in the above definition.

First, what does Friedman mean by the "Walrasian system"? At the time of his statement, the Arrow-Debreu model of intertemporal equilibrium was becoming the canonical statement of general equilibrium theory. But the Arrow-Debreu model is a very short run model, in which the initial quantities of capital equipment are among the given endowments. Consequently, a solution to the model yields neither a rate of employment nor a rate of unemployment, independent of time. Rather, these rates are time-varying. So he cannot mean to refer to that model.

Now, Walras himself presented a model with given quantities of capital goods and a supposed steady state set of prices and quantities. But this model was just logically inconsistent. In consistent long-run economic models the set of capital goods are found by solving the model, not taken as givens. Thus, the logic of such models is not about allocating given resources among alternative ends. To refer to such a model as "the Walrasian system of general equilibrium" is dubious.

Second, Friedman's definition relies on an implicit mathematical theorem: that the equilibrium solution of whatever model he is talking about is unique. But no reason exists for such a theorem to hold in either the Arrow-Debreu model or a long run equilibrium model with many markets. I have myself created a model with multiple equilibria.

Here, then, is another example of right-leaning economists giving decades of policy advice based on theoretical claims with no support in economic theory. Unsurprisingly, the policy did not work empirically either, as can be seen by looking at results in the 1980s and 1990s. (These claims are not new. James Galbraith made my second point long ago.)

Have mainstream economists ever addressed this failure? Did they not mostly just continue their mistake with Dynamic Stochastic General Equilibrium (DSGE) models?

Sunday, May 16, 2010

Economics can change the world, and not necessarily for the better. Mainstream economists often do not describe actual capitalist economies, but theorize an imaginary, supposedly ideal world in which everybody pursues their own self-interest, narrowly defined. Participants in this world are then sometimes encouraged by the theory to change institutions and their behavior to come closer to that imaginary world.

This post describes theories that encouraged corporations to become more vulnerable, by taking on large amounts of debt, and to become more short-run oriented, by focusing more on immediate stock market prices. I know about these two contributions to economics more from Bernstein and Cassidy's popularizations than the primary literature. I am deliberately treating some elements that I think have not much appeared in popular discussion since the advent of the global financial crisis.

2.0 Modigliani and Miller (M&M) and Capital Structure

The Modigliani and Miller theorem states that whether a corporation obtains financing with stocks or with bonds has no impact on its stock price. I gather that this follows from an arbitrage argument under admittedly unrealistic assumptions. An individual can buy stock with borrowed money. By buying stock on the margin, individuals can raise the leverage ratio from whatever corporations have decided on to whatever they like.

The M&M theorem serves as a baseline in corporate finance. One considers the implications of existing deviations from the theorem assumptions. Apparently the treatment for corporate taxes in the United States of dividends and interest is one such deviation. Interest on bonds can be deducted as expenses on corporate taxes; stock dividends cannot. Therefore financing by issuing bonds is to be preferred.

"This [proposition] carried not very flattering implications for the top managements of companies with low levels of debt. It suggested that the high bond ratings of such companies in which the management took so much pride, may actually have been a sign of their incompetence; that the managers were leaving too much of their stockholders' money on the table in the form of unnecessary corporate income tax payments [of] many millions of dollars." -- Merton Miller (1988), quoted in Bernstein (2005)

The implication is that corporations should increase their leverage.

3.0 Michael Jensen and Executive Compensation

Most owners (that is, holders of stock) of modern corporations are absentee owners. They would like corporate executives to act in a non self-dealing manner, against their own interests. This is a principal agent problem. The stock holder is the principal, the Chief Executive Officer (CEO), for instance, is an agent. In theory, the problem is how to structure executive pay and corporate incentives such that in value of stock is maximized. (I gather that in this theory, social norms about how stockholders, traders, and executives should behave doesn't come into it.) A supposed answer to the principal agent problem is to pay executives partly with stock options. They will then be encouraged to do their utmost to ensure the market price of the stock exceeds the price specified in their options.

Thursday, May 13, 2010

Ian Parker has an article, "The Poverty Lab", in this week's(May 17, 2010) issue of The New Yorker. This article is a profile of Esther Duflo, this year's winner of the John Bates Clark award and a co-founder of the Abdul Latif Jameel Poverty Action Lab (J-PAL). J-PAL conducts controlled experiments in the field in developing countries.

This is neat work. As I understand it, it can be extended. Does J-PAL conduct experiments designed to implement more than one treatment at once? In such experiments, one would analyze the results with Analysis Of Variance (ANOVA), instead of a T test (or the Mann-Whitney-Wilcoxon test, which is the corresponding nonparametric test). This would probably be challenging on the scale of their experiments, but part of the point of the design of experiments is to allocate resources efficiently.

Field experiments, in some sense, are an extension of the methodology of laboratory experiments, seen in the work of, for example, Daniel Kahneman and Amos Tversky. The design of experiments could also be extended back into theory by applying it to simulations and computer programs implementing theoretical models. Duflo's work tells us about the world, while this would tell us more about economic theory. I'm thinking of Stefano Zambelli's work on aggregate production functions.

Saturday, May 08, 2010

1.0 IntroductionJoan Robinson famously distinguished between economic models set in logical and historical time. According to Robinson, the distinguishing feature of Keynes’ General Theory is its setting in historical time. Building on Paul Davidson, one might say that one sign that a model is set in historical time is that it generates nonergodic stochastic processes.

2.0 Spherically Invariant Random Processes (SIRPs)A stochastic process, {X(i), i = 0, 1, ..., n - 1}, is an indexed set of random variables. Typically, the index is taken to be time. Each random variable X(i) has an associated probability distribution, which can be specified by a Cumulative Distribution Function (CDF):

Fi(x) = Prob( X(i) ≤ x),

where Fi is the CDF. The derivative of the CDF is the Probability Density Function (PDF). (I guess differentiation, in this sense, is the inverse operation of Lebesque-Stieltjes integration.)

If the stochastic process {X(i), i = 0, 1, ..., n - 1} is a SIRP, it can be represented as the product

X(i) = YZ(i), i = 0, 1, ..., n - 1,

where Y is a random variable not indexed on time and Z(i) is from a Gaussian distribution with a mean of zero.

2.1 A Single RealizationTo consider an example, I picked a distribution for Y, namely the Chi distribution. (A random variable is from a Chi distribution if it is the square root of a random variable from a Chi Squared distribution.) Arbitrarily, I set the degrees of freedom of the corresponding Chi Squared distribution to be 2. For simplicity, let the variance of the normally distributed random variables {Z(i), i = 0, 1, ..., n - 1} be unity.

Figure 1 shows 100 time samples generated from this stochastic process. A single realization y of the Chi distribution is generated for each realization of the SIRP. The time samples consist of the product of this value and 100 realizations generated from a standard normal distribution. Figure 2 is a histogram formed from these 100 time samples. Does the histogram look bell-shaped?

Figure 1: A Realization of a Random Process

Figure 2: Distribution Over Time

2.2 Many RealizationsI generated 100 realizations of this SIRP, each consisting of 100 time samples. Consider a fixed time sample, say i = 4. The 100 realizations of the SIRP allow one to create a sample of the value of the SIRP at this time sample. Figure 3 shows the resulting distribution. The distribution shown reflects variation resulting from the Chi distribution, as well as the variation in the Gaussian distribution. I don’t find it obvious to the eye that this distribution is peaked differently (has a different kurtosis) than a Gaussian distribution.

Figure 3: Distribution Across Realizations

2.3 Nonergodic Stochastic ProcessesFigures 2 and 3 are constructed from two random samples, each of 100 points. These samples can each be used to estimate parameters of the stochastic process – for example, the CDF at specified values. If the stochastic process were ergodic such estimates would converge as the sample sizes increased. That is, an estimator based on a large enough number of time samples from a single realization would be equally as good, in some sense, as an estimator based on data across a large enough number of realization at a specified time sample.

But this SIRP is nonergodic. Figure 4 shows the CDFs estimated from the two random samples. The Kolmogorov-Smirnov statistic provides a formal statistical test for deciding whether the difference between these two estimates of the CDF can be explained by random variation. And that test rejects the null hypothesis at a 5% level of statistical significance. To summarize – this post has presented a Monte Carlo demonstration that a SIRP can be nonergodic. The question raised for the economist is whether their theories apply if stochastic processes observed in actual economies (for example, the prices of stocks) are nonergodic.

"Still complaining that GE theory doesn't deal with reswitching and other sraffian critiques when it clearly does."

I don't know what that response is about. I follow Barkley Rosser, Jr., in thinking that reswitching points to the possibility of some interesting dynamics in General Equilibrium models. And I know of no adequate response to Fabio Petri's critique of General Equilibrium theory, particularly what he calls the impermance problem.

This has nothing to do with me. But I thought I'd quote it for an illustration of a completely wrong opinion:

"A related paper of interest is Mas-Collel (1989), 'Capital Theory Paradoxes: Anything Goes,' which notes that the 'problems' coming from aggregating capital are very much related to the Anything Goes theory of Sonnenschein-Mantel-Debreu, and about as problematic to neoclassical theory (meaning, not very problematic)."

Sunday, May 02, 2010

A comprehensive history of physics would not be only about changing ideas and the social setting in which they evolved. It would include stories of many experiments. One might talk about Galileo, the moons of Jupiter, inclined planes, and pendulums. One would have experiments that demonstrate a result long after physicists became convinced of it for other reasons. I think Foucault'a pendulum and the rotation of the earth falls into this category. And one would have empirical results that were cited at times of paradigm shifts - for example, the Michelson Morley experiment and precession of Mercury's orbit for Einstein's theory of special and general relativity, respectively.

What would go into a corresponding history of economics? I suppose one would mention unemployment in the Great Depression and stagflation during the 1970s. Notice these phenomena are not controlled experiments. Vernon Smith's experiments would enter into such a history. I'm not sure where Kahneman and Tversky's prospect theory would go. I suppose it is a triumph for neoclassical economics that it can be formulated sufficiently rigorously that it can be shown experimentally to be false. I suppose natural and field experiments are too recent to get a good historical perspective on. Looking back, one might mention Wesley Clair Mitchell and the National Bureau of Economic Research. I like Wassily Leontief's work. One might mention Richard Stone and work on setting up the system of national accounts. But, as far as I am aware, this gathering of a body of empirical data is not tightly linked to changes in economic theory. What am I missing?